Commerce Bancshares

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Commerce Bancshares, Inc. is a large U.S. regional bank holding company that offers various financial services, including banking, insurance, and wealth management.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Commerce Bancshares (CBSH) operates as a diversified financial services provider, primarily engaged in commercial and retail banking within a multi-state region. The company’s core business model revolves around serving its diverse clientele with various offerings including: traditional deposit taking, lending, wealth management, and insurance services.

  • Revenue Distribution:
    • Net interest income: This is the primary driver of revenue for any bank. CBSH generates revenue from interest earned on loans, less the interest paid on deposits. They have a diversified loan portfolio including commercial and industrial, real estate, consumer, and other lending. In the current elevated rate environment, they have a tailwind on their earnings from higher interest rate income.
    • Fee and commission income: This line of revenue includes charges for various customer services, such as investment advisory, broker-dealer and mortgage services.
    • Trading income: Trading income arises from the bank’s proprietary trading activities. This category’s volatility varies depending on their exposure to the stock and bond market. Other noninterest income are from other services.
  • Industry Trends:
    • Consolidation: The U.S. banking industry has experienced significant consolidation over the past several decades, leading to fewer but bigger players. Scale is important in this business for greater operating efficiency and to invest in higher technology which is essential for remaining competitive.
    • Digital Disruption: Modern banking customers expect seamless online services. It will be increasingly important for banks to digitize their services in the future. They need to adapt to modern preferences, such as mobile banking and online services. However, banks must not fail to adhere to basic principles of relationship-banking.
    • Regulatory Scrutiny: Banking is a heavily regulated industry, and constantly faces new regulations and scrutiny that can significantly affect its profitability. Banks should be ready to adapt to the continuously changing regulatory environment.
  • Margins:
    • Looking at the latest income statement, for the three months ending in September 2023, the interest margin was 3.19%, down from 3.26% in the same period last year, and down from 3.42% YoY. This is due to the increase in deposit rates, and also because there is less opportunity to acquire assets at higher rates due to the rapid increase in federal interest rates.
  • Competitive Landscape:
    • The banking sector faces intense competition from traditional banks and online-only banks. New entrants in banking, and the high concentration in the sector, means companies need strong differentiators to survive and thrive.
    • The company has many large competitors, like Bank of America and JP Morgan Chase. There are also smaller more localized banks, which operate regionally.
    • CBSH’s financial position relative to that of its peers is adequate in terms of its scale and profitability and thus its financial performance is likely to track the market.

What Sets CBSH Apart: While they are a regional bank, they differentiate themselves from many similar banks in some ways:

  • Diversification: They have an established wealth management business as well, which provides a good source of fee-based income. Many other similar regional banks lack a wealth management business to this size and quality.
  • Strong Credit Culture: CBSH has historically been conservative in lending, which has resulted in lower loan losses over the long term, allowing them to maintain their capital position and profitability even during periods of financial turmoil.
  • Relationship Banking: They value local knowledge and strive to serve their customers by building strong relationships, even though many customers are moving to online banking practices.

Financial Analysis:

  • Profitability: For the nine months ended September 30, 2023, CBSH reported total net revenues of $1,693 million, which is a 10% increase compared to the same period last year, with net interest income growth of 16.1% and non-interest income loss of -1.3%. This signifies that while their core business is performing well, their trading revenue or other services revenue may vary during the course of the financial year. The overall net income is $491 million which is up 34%. The management attributed this increase to the increase in interest rates and also an increase in volumes of banking activities.
    • Their return on equity is 11.4% for the nine months. This demonstrates their profitability, but many other banks may have a higher return on equity.
    • Their current profit margin stands at 28.4% which is quite adequate for a bank, as it has to use a lot of its profits to keep the business running.
  • Balance Sheet Health: Overall, the balance sheet of CBSH is quite healthy. At the end of Q3 2023, they had total assets of $31.5 billion, including $17.2 billion in total loans and $10.8 billion in investment securities.
    • Their current assets/current liabilities ratio is over 2.6x, which is very strong and allows the company to continue operating effectively.
    • Their tangible book value is $31.67 per share, which does not look like it is too high or too low relative to a bank.
    • Their leverage ratio at 9.8%, signifies that the company has a large amount of assets relative to their capital, which can make them a bit vulnerable to financial shocks.
  • Controversies and Problems
    • During the earnings call, management discussed that some of the noninterest income losses in Q3, were because they had less income from mortgage banking, because of lower mortgage applications, and higher rates, which had reduced the total revenue. However, the management had emphasized that they still had decent returns over all and were growing quite aggressively.
    • There were some concerns regarding the possibility of future rate cuts, which could cause net interest margin contraction. However, the management had communicated that they expect the bank’s performance to be pretty strong for the short term.
    • The management had also stated during the conference call, that the bank is highly focused on deposit growth and were increasing their presence in more stable and low cost deposits.
    • Another point was their intention to increase their loan to deposit ratio to above 100% in the future, to improve their loan yields.

Moat Rating: 3/5 While not an industry leader, CBSH has developed a moat primarily through its strong brand image, high customer switching costs, strong local presence, and stable balance sheet. However, since the banking industry is highly competitive and heavily regulated, this moat is narrow instead of a wider one.

  1. Intangible Asset: Brand recognition and local presence: CBSH has a recognizable brand within its primary regions, which has earned the trust of local communities. This trust along with the physical local presence of the company is a source of economic moat.
  2. Switching costs: Switching from a primary bank is a major ordeal for most customers, and thus leads to high stickiness of deposits and loan facilities.
  3. Cost Advantage: CBSH has been a historically conservative lender, and a cost-effective operator, helping the bank achieve a moderate competitive advantage over its peers.
  4. Economic Moat Durability: The moat of the bank is susceptible to industry dynamics and changes in preferences. Digitization, rate changes, regulations and other changes may weaken or nullify the competitive advantage that the bank has created. Thus, its economic moat is rated as a narrow moat.

Risks to the Moat & Business Resilience:

  1. Economic Downturns: Being a bank, CBSH is especially vulnerable to economic downturns, which are likely to increase loan defaults, and reduce new lending activities.
  2. Regulatory Changes: Banks are required to maintain adequate levels of capital for their lending, and new regulations may result in lower net income and margins.
  3. Changes in Interest Rates: The recent rapid increases in interest rates, have given a tailwind to their earnings. However, if the federal reserve changes their stance and decreases the interest rates, the company might suffer reduced revenues, margins, and thus profits.
  4. Technological Disruption: New entrants into the banking space may come with innovative technologies, that are more effective than their current infrastructure, hurting their market share and revenue.
  5. Cybersecurity Risks: Cyber attacks and leaks of sensitive information is a serious threat that they always face, and their security system will need to continuously adapt to the latest threats. Despite these risks, the bank is likely to survive and thrive over the long term, because of its well established brand and a good local presence. The company’s financial position is also solid, giving it the capability to tackle these challenges. However, it does not have a big edge over its peers to establish an extraordinary level of business resilience.

Understandability: 2/5 While the basic business model of the bank is easily understandable (borrowing at low interest rates and lending at higher ones), the business is extremely complex for outsiders in the details. It requires significant training to fully comprehend all the details of operations, regulations, and risk metrics, and thus the business cannot be categorized as very simple.

Balance Sheet Health: 4/5 The overall health of the balance sheet seems decent. The debt-to-equity ratio is very manageable, the core operations are quite profitable, and it does not have excessive debt, even though it does have significant financial instruments, that can increase their leverage significantly. The long term solvency of the company seems quite high. Overall, the balance sheet is pretty good and is in a good enough position to weather a financial storm.